New Zealand Court of Appeal guidance on penalty law

The law regarding penalties as it applies to contracts has recently been revisited by superior courts in both the UK[1] and Australia.[2] Our Court of Appeal has now considered these developments.

In Wilaci Pty Ltd v Torchlight Fund No 1 LP [3] the Court of Appeal has held that a Late Payment Fee under a commercial loan by Wilaci to Torchlight is not a penalty. As a result, the fee of over A$31.477 million is payable to Wilaci.

This case is relevant to any business which utilises Late Payment Fee clauses or any other liquidated damages clauses in their contracts. Although the loan was governed by New South Wales law, the same principles are likely to apply to New Zealand law governed contracts. The decision is therefore likely to influence how the New Zealand courts now approach these types of clauses.

Key facts

Wilaci lent A$37m to Torchlight (an entity associated with George Kerr). The key terms of the loan were:

An Establishment Fee for the loan was payable.

The loan was to be repaid in full in 60 days, during which time interest would accrue.

If the loan was not repaid in full after the 60 days, a Late Payment Fee of A$500,000 per week would apply.

Torchlight did not repay the loan after 60 days and Wilaci sought payment of the Late Payment Fee.[4] Torchlight refused and argued that the fee was an unenforceable penalty. Torchlight succeeded in the High Court. The matter came before the Court of Appeal as a result of an appeal of that decision brought by Wilaci.

What traditionally makes a fee a penalty?

Under traditional legal principles:

a fee is a penalty if:

– it is payable on breach of a term of a contract; and[5]

– the payment is extravagant in comparison to the genuine pre-estimate of loss.

If a clause had the purpose of deterring a party from breaching, then it was likely to be a penalty.

If a fee is found to be a penalty, then it is unenforceable. However, as discussed in the Torchlight decision recent overseas cases have broadened the above principles. For instance:

there may be other broader legitimate interests (apart from loss suffered) that are relevant to whether a clause is a penalty; and

the fact that a clause is designed to deter a party from breaching, does not mean that it is necessarily a penalty.

The arguments

Torchlight argued that the fee was a penalty as it was extravagant in comparison to the loss that Wilaci could have been suffered on delayed repayment. The fee amounted to an 80% return on the $37m loan.

Wilaci said the Late Payment Fee was not a penalty. First, it said the fee was not payable on breach of a term, but was instead the price for Torchlight continuing to have the benefit of the loan after day 60 when Torchlight did not repay. It also said the amount of the Late Payment Fee was not extravagant. The fee worked out to be around $2.5m a month (slightly less than the combined monthly cost of the Establishment Fee and interest for the 60 day term).

The Court of Appeal’s decision

The Court held that the Late Payment Fee was payable on breach of a term and therefore was capable of being a penalty. However, the Court decided that the Late Payment Fee was not a penalty for the following key reasons:

This was a high risk transaction and therefore the returns for Wilaci needed to be substantial. The Court found that the fee payable on breach was, in fact, lower than the cost of credit prior to default and therefore the fee was not extravagant.

Both parties were sophisticated commercial parties. As such, they were the best judges of what was an enforceable consequence of a breach.

Our view

The approach taken by the Court of Appeal suggests that it will be less willing to find that a clause negotiated between sophisticated parties is a penalty. This means that commercial lenders and businesses need to consider late payment fees and other liquidated damages clauses carefully. The Courts will also look at broader legitimate interests of the parties (not just the loss suffered).

What next?

It remains to be seen whether leave is sought to appeal the decision to the Supreme Court.

If you have any queries regarding this case or concerning liquidated damages clauses or penalties, please contact one of our experts.

The loan, Establishment Fee and interest during the 60 day term of the loan was paid by the time of trial.

There is also an issue regarding whether there is a penalty at equity (which does not require the amount to be payable on breach). A key example of a penalty at equity would be early termination fees which permit a party to exit a contract (so there is no breach) but the fee encourages a party to continue with the contract. While the UK Supreme Court and the High Court of Australia take a different view on the point, this was not relevant to the Torchlight proceeding.